The 75/50 Portfolio: A Process Drilldown

by: Roger Nusbaum

IndexUniverse posted a lengthy article by John Serrapere recapping the latest quarter for his 75/50 portfolio. The 75/50 means that the portfolio tries to capture 75% of the market's upside with only 50% of the downside over the course of a stock market cycle.

The portfolio, and articles about the portfolio, are long running at IndexUniverse and can be a very constructive read. He quantifies (75 and 50) specific targets, in contrast to my simply looking to go down less (this will mean different things at different times) during bear phases and go along for the ride to the upside. The way this has played out for me has been down less. I have had a couple of years being very close to the market during up years and one year that the SPX was up very little and I was up a lot. Generally, I expect to lag a little when the market is up a lot and hope to do well the rest of the time including hoping to go down less when the market goes down a lot.

Despite those differences I believe there is some conceptual overlap between what I do and write about and what Serrapere does. Another big difference however is in portfolio construction. Page 8 of the article discloses Serrapere's portfolio and it is interesting, revealing and constructive for learning about blending things together.

Below is the portfolio:

  • AMJ 3.5%
  • ARBFX 3.7%
  • DBA 4.9%
  • EWZ 3.2%
  • GAF 3.2%
  • GDX 12.9%
  • GIM 12.8%
  • GLD 12.8%
  • JRS 3.9% (short position)
  • MERFX 3.7%
  • MOO 3.0%
  • PXJ 3.3%
  • TBT 24.7% (thought of as a short/hedge position)
  • TDF 3.1%
  • TIP 7.1%
  • VXX 7.4% (thought of as a short/hedge position)
  • VXZ 7.5% (thought of as a short/hedge position)
  • XLE 3.9%

In the article, Serrapere mentions this mix being up not quite 11% on the year versus about 17% for the SPX at the quarter end. For the the first three quarters, he came up a little short of the 75% but hats off to him for getting so close with this mix (obviously there have been changes along the way that I did not catalog). What I mean is that when he hedges, he goes heavy, much heavier into buying products than I do. My position in SDS grew to about 5% of the portfolio at one point which combined with what was then a very large cash position served to be a very effective hedge. If I remember correctly, when the SPX was at the low in March it was down 25% for the year and I think I may have been down about 10%.

Whatever the exact numbers were back then, the hedge was simple: a little SDS, a lot of cash and generally underweight volatility. These days the cash level has come down and the few additions I've made have been relatively volatile.

Serrapere's willingness to go heavy, 24% in TBT and 15% between the two VIX ETNs, goes far beyond anything I'm comfortable with. In building a diversified portfolio you are guaranteed to be wrong about at least a couple of things. In looking at 40 holdings (about what I use) I know a few things will not work out as hoped for, or something may work very well for a while but then not (or vice versa). An example of this is Monsanto (NYSE:MON). Many clients own it. I bought it a while ago in the high $80s. It skyrocketed at first and I sold some just above $120. At that time it was working great. Then it came in with the market which is no shock but has lagged this rally by a lot. I have no doubt it will "work again" but for the rally it has not behaved as hoped for.

The target weight for MON is about 2%, so had it endured some sort of calamitous decline it would not create a big drag on the portfolio. In contrast, Serrapere's 25% to gold (12% each to GDX and GLD, which clients own) could have backfired badly had gold gone down. Yes, he could have sold ahead of such a decline but would you? I don't want to have to be right about something like this (what if they dropped 8% you sell and then they both go up 50%?).

In terms of creating specific portfolio effects or characteristics, I think it is much easier to go narrower than Serrapere by using individual stocks as part of the mix and avoiding certain things in ETFs (like avoiding financials in Brazil by using a mining stock instead of EWZ) and my fondness for Norway has turned out to be very lucky--these are tough to capture in ETFs for now.

It is not my intention to be overly critical, because he was very close to his objective. My intention is to point out that there is more than one way to target any end result. I believe, as mentioned above, he and I share some conceptual beliefs. I think his path to his result is the more difficult path and I imagine he would say something similar about my portfolio and have other criticisms.

If you believe in taking little bits of process from many places to create your own process then you must look at other people's process with both a critical and constructive eye and clearly there is plenty we can learn from Serrapere's process.

A quick funny: Richard Kang was on CNBC Asia on Thursday morning and had a great one-liner, saying that US T-bills had gone from being risk-free return to return-free risk.